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Monthly Archives: October 2013

According to Standard & Poor, the American economy lost $24B as a result of the shutdown of the federal government. But the suggestion is without substantiation & fails as a matter of economic logic.

It turns out that the shutdown merely shifted or diverted spending from one destination to another or changed its timing. As such, there is no significant net change to the overall economy since it was mostly about a redistribution of spending from place to place or across time.

Among the identified “losses” are wages by federal employees & contractors as well as the value of lost government services.

While business owners that depend on tourists visiting shuttered federal facilities, their losses are offset by gains elsewhere. While some firms might have lost money or visitors during the shutdown, some other businesses must have had more customers than they might have as holidaymakers went elsewhere. Or if they cancelled their vacations or did not spend the money, they will have saved those funds, making them available for lending to boost investments.

The notion of “lost” spending reflects an inverted lapse of logic revealed in Bastiat’s “broken window fallacy” that depicts receipt of money spent on fixing a broken window as a net gain to the economy. Inasmuch as those funds would have been spent elsewhere in the economy were they not used to repair the window, they cannot involve a net economic gain.

In a similar, albeit inverse manner, whatever went unspent in one sector of the economy during the shutdown was either spent elsewhere then or will be in the future.

As it is, the notion of “lost” wages is poppycock since federal employees will receive back pay despite not having worked during the shutdown so that spending by them is merely deferred from then to now or later.

Perhaps only federal contractors will lose wages as a consequence of the shutdown, but whatever is not paid for them does not evaporate and will either lower the deficit or be spent elsewhere by the federal government.

“There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, & does it in a manner which not one man in a million is able to diagnose.”
~J.M. Keynes~

“Weighed against the political, social and economic risks of continued slow growth after a once-in-a-century financial crisis, a sustained burst of moderate inflation is not something to worry about, It should be embraced.”
~Kenneth S. Rogoff~

In a move to give some credibility to a really & truly stupid idea, the NYT has rounded up a gang of economist-fabulists to explain why everyone should learn to love, now wait for this, HIGHER PRICES.

Those foolish souls among you that believe that LOWER prices are good will find this a “must read”.

Of course, much of this is to give cover to Janet Yellen, the presumptimve nominee to head the Fed as of next year. For her part, he on record declaring that a “little inflation” is useful when the economy is weak. Presumably, the reference is to a rising (consumer) price index that itself is one of the several possible outcomes from central bankers inflating the money supply, which is the original definition of inflation.

In a bit of tortured logic, firms love rising price levels as a means to boost profits. But this only works if input costs (e.g., wages & salaries) rise less rapidly than output prices. Yet the same workers whose wages lag behind prices are supposedly earning (phantom?) wage hikes so they are better able to repay debt. (Like Keynes, this arguments shows an inclination to have it both ways.)

And then there is, the tried-and-true canard that consumer price inflation induces households & firms borrow more money & spend it more quickly. What this overlooks is that banks, as now, may find it cheaper & less risky to buy sovereign debt or purchase other financial assets rather than lend to small businesses or consumers.

While the US government is a clear beneficiary of a rising price level in repaying its debt with dollars that buy less than those originally lent to it, this is only advantageous if the debt is rolled over at the same interest rate, an unlikely outcome if price hikes are substantial.

Of course, Yellen is in concert with her likely predecessor, Ben Bernanke, who believes that “… falling & low inflation can be very bad for an economy.” This bit of inanity is beyond the pale in presuming that incrementally small rises in price levels could collapse into to a sharp decline the price level. Yet this sort problem only arises when central bankers monumentally mismanage the money supply as they did after the Stock Market Crash of 1929.

Just in case you tuned out, HIGHER prices are always good & LOWER prices (even smallish increases in prices) are always bad!?!

“The (US) Constitution is a charter of negative liberties. It says only what the government cannot do to you, not what the government is obligated to do on your behalf.”
~Barack Obama~

The author of this statement reveals a profound ignorance of misinformation about the US Constitution.

It provided a set of powers available to the government of the newly-formed Republic such that whatever is not listed is not a permissible act by the federal government, i.e., it is “unconstitutional” since there is no constitutional authority for government to act beyond those specific powers.

As it is, the Constitution specifies 18 enumerated powers available to the American federal government.

Indeed, any high school civics student would know that the Bill of Rights were amendments that outlined certain liberties or rights. Even so, the Bill of Rights was written to serve as an injunction against government interfering with such certain freedoms.

Alan Greenspan spoke to the WSJ about his new book & both seem to be an attempt to launder his career that ended on a rather dubious note as architect of the housing “bubble” that brought on the Great Recession. His masterly manipulations of interest rates massively under-priced risk & artificially-cheap credit sparked an artificial boom that pumped air into the prices of various assets & commodities.

The rot began on Sir Alan’s watch in 1997 when he was rolled by Robert Rubin, then US Treasury Secretary, to flood global capital markets with liquidity after a credit crunch in financial market in countries in East and Southeast Asia leading to exchange rate meltdowns. Rubin, an insider whose expertise is “fixing deals” rather than understanding how markets function, insisted that the inherent instability of capital markets made it necessary to intervene.

Doubtless, the good Treasury Secretary was just as worried about his pals on Wall Street as when he helped engineer similar interventions to the Tequila Crisis of 1994. As it is, much of the high-interest bearing Mexican debt was distributed by Rubin’s former firm, Goldman Sachs, or was being held by other Wall Street financial interests. In turn, a controversial use was made of the US Treasury’s Exchange Stabilization Fund (along with other assistance from IMF).

As a keen observer of Asian economies prior to the 1997 debacle there, it was my impression that propping up Mexico’s “Tesobonos” created “moral hazard” in providing precedence for taxpayers being put on the hook for financial-sector misbehavior. Indeed, it could be said that the response to the “Tequila Crisis” provided a template for bail-outs since then, including the TARP in the aftermath of the 2007 housing crash.

It is unsurprisingly that Greenspan deflects blame from central banks, & by implication himself, by conjuring up explanations for bubbles based on “pop-psychology”. In his interview he adds “fear” as a human element to join his famous quip about “irrational exuberance” to explain what he views as part of mass hysteria that supposedly drove housing or other asset prices to unsustainable levels.

Of course, a good & honest economist would turn to economic explanations for “bubbles” available in Austrian Business Cycle Theory (ABCT). It turns out that ABCT lays the blame squarely at the feet of Sir Alan & his ilk that would play god with money & interest rates to provide the fuel that pumps air into asset or commodity bubbles.

Perhaps Greenspan’s greatest economic sin was his guise as an omniscient “central planner” to engage in the equivalent of price-fixing to set interest at increasingly-absurd low rates. In so doing, it set into motion a variety of distortions that even an undergraduate student of economics would have warned against.

For his part,, Greenspan & his successor Ben Bernanke, are responsible for one of the most massive destruction of wealth in the history of mankind. And by introducing “financial repression” to keep interest rates far below market (“natural”) rates, income disparities have widened in favor of financial sector insiders & those with the means to leverage their debts. With so few new loans made to start-up firms, labor remains in excess supply, keeping down real wages increases so that the disparity looks even worse.

And so long periods of artificially-low interest rates also prompted a cycle of economic “financialization” whereby resources were diverted away from the real sector into the banking sector & to facilitate the ballooning of sovereign debt around the world as other central bankers joined the game.

As it is, there has been very little growth in bank loans to the private-sector since 2007. This is because bankers find lending to governments to be less risky & to be cheaper since there is no need to hire loan officers to evaluate loan requests or collateral.

The Fed policy of hyper-low interest rates provided liquidity that drove down the returns on cash, so that investors sought other assets to gain higher income, driving up the value of almost every class of assets.

Of equally destructive force is the impact of under-pricing credit invites
interest rates to artificially-low levels will cause distortions in the production structure of the private economy. Pumping newly-printed money and cheap credit into the economy provide funding for weak business plans with low rates of return that would not be able to secure financing at higher interest rates.

Indeed, allowing access to borrowing at temporarily-cheap credit will doom many business ventures with low rates of profitability that will be washed away in a tide of rising credit costs. This is because it is impossible for interest rates to be suppressed forever without either sparking massive increases in consumer & producer prices.

Alas, this is all likely to end very badly once expectations shift towards higher interest rates, causing a rapid reversal from inflated valuations that will wipe out enormous amounts of capital.

It might be said that Alan Greenspan is a either a heinous villain that willfully sought to weaken the US economy & destroy the credibility of the dollar or he is so impervious to logic that he is a …(the reader is invited to fill in their own noun here)… .

About 18.5% of the estimated total of 4.4 million federal government employees, including all military & postal service employees, are affected by shutdown-induced furloughs. The average federal employee’s annual income is $74,436 or just over 24% more than the average income of earned by full-time employees. (Federal employees also receive benefits worth about $40,000 each year.)

In turn, the average saving from the budget for each furloughed federal government employee is about $300 per workday. So that with about 816,000 employees on furlough the total saving per day from the furlough is about $244,800,000.

This is good news unless you believe the Keynesian trope that consumption drives economic growth. Of course, this illusion is reinforced by the calculation of GDP that purportedly shows that private spending accounts for more than 2/3s of all economic activity.

What should be an obvious mistake in interpreting GDP as an indication of real economic improvement is that consumption based on newly-issued paper money & artificially-cheap credit is illusory & unsustainable.

From the other side of the ledger concerning salaries paid to public-sector employees, most are not productive since they do not produce additional goods or services for sale in the market economy. Indeed, many government employees are “parasitic” in the sense that they draw from the pool of taxes taken involuntarily from productive private-sector workers.

Since public-sector employees do not produce goods or services for sale in the market, whatever they spend merely returning funds to the private economy that were forcibly taken by tax authorities.

Imaging that lower incomes of government employees reduces economic output requires a leap of faith that their spending somehow has a magical multiplier effect not present if the funds were spent by private actors. In fact, the argument might be the contrary since funding government is usually associated with dead-weight losses that are being reduced.

In all events, the designation of non-essential government personnel reveals that their activities does not contribute sufficiently to the public weal. In turn, that seems to be an argument that these jobs should be cancelled so that the funds used to pay for them can be released to the productive, private sector of the economy.

When you lose the CBO, maybe; just maybe, you lose middle America by speaking common sense:

“The increase in debt relative to the size of the economy, combined with an increase in marginal tax rates (the rates that would apply to an additional dollar of income), would reduce output and raise interest rates relative to the benchmark economic projections that CBO used in producing the extended baseline. Those economic differences would lead to lower federal revenues & higher interest payments. … At some point, investors would begin to doubt the government’s willingness or ability to pay U.S. debt obligations, making it more difficult or more expensive for the government to borrow money. Moreover, even before that point was reached, the high & rising amount of debt that CBO projects under the extended baseline would have significant negative consequences for both the economy & the federal budget.”

CBO “Long-Term Budget Outlook” (2013)
Deficit Spending Matters:

The US federal deficit fell to about 4% of GDP this year from 10% peak in 2009. But while discretionary expenditure was cut, entitlement spending rose so that the deficit will likely exceed 6% by 2038. In turn, this affects CBO projections for the ratio of public-sector debt to GDP that was thought to be 52% by 2038 but is now expected to be about 100%, perhaps rising to above 200% by 2076.

The graph above shows how irresponsible monetary policy caused financialization & de-industrialization of the US economy. With so few new loans going to private-sector ventures, it should be no surprise that the ratio of private-sector workers to total population has declined so sharply.

Consider how risk perceptions were distorted by centralized repression of interest rates to put them at absurdly-low rates to support exploding government debt so resources were diverted from the private sector to the public sector.

There might a been a different picture if markets had not been flooded with liquidity that provided fuel & pumped air into bubbles or low rates that discourage saving & reduced income & earnings for households.

Those that would attribute any of this to a failure of markets (capitalism) must willfully ignore how monetary policy suffocated markets & then blame them for failing!

Financialization involves a shift in economic gravity from production & from the service sector to the financial sector. Similarly, financial assets are diverted away from the private sector to the public sector as deficits remain high & debt accumulates at a worrying rate.

What should be seen is that what we are witnessing is a monetary-policy induced de-industrialization of the US economy.

Knowing that all this is happening is one thing, but it is important to know what is the fundamental cause behind this transformation. There are many that would blame globalization or economic liberalization & reply by suggesting that there must be more regulations or government interventions. Alas, those that believe this tend to be in the majority of economic advisers.

What they overlook is that the process of financialization of the US economy is driven by non-conventional monetary policies that have kept interest so low for so long and financial markets awash with excess liquidity. In turn, these monetary policies are also the culprit behind a sluggish & incomplete recovery from the Great Recession of 2007-2008.

Whereas such artificially-low interest rates were justified as a means to encourage business investments or home purchases, banks face weak incentives to offer credit to either firms or households. The reason is that it is more costly & risky to make loans to start-up businesses or households than to trade financial assets.

To issue new loans, banks must hire more loan managers to review applications, other staff to assess value of collateral (or to collect it & dispose of it) & accountants to keep track of all this. The above graph clearly indicates that there is very little loan growth.

And low interest rates also discourage saving by firms & households that are more likely to seek a “flutter” in placing surplus income in more risky & (hopefully) more remunerative financial assets, like bonds or stocks. Inasmuch as there have been fewer IPOs for new companies, most of the trading of shares is of companies that already exist.

Despite the slow growth in new lending, many of the largest banks are earning record profits, especially those banks that are “primary dealers” & act as exclusive counter-parties to support the Feds open market operations. “Quantitative easing” programs involved the New York Fed purchasing Treasuries from primary dealer banks, including Goldman Sachs, J.P. Morgan and 18 others.

These banks receive payment for Treasures they received as part of the bailouts in exchange for toxic assets that came off of their balance sheets, all of this done at taxpayer expense.

Before the introduction of “unconventional” monetary policy, financial assets served as contingent claims such that expanding the scope of financial markets and instruments would tend to increase overall efficiency. In turn, markets could do a better job pricing future outcomes to improve current allocation of resources relative to anticipated future needs and economic actors could seek portfolios with higher returns relative to risks.

With central bankers around the world following the lead of the FED, financial assets are busy chasing bubbles around the world with little left to spark a solid economic recovery and sustainable new job creation. As long as these bubble opportunities exist & yield high rates of returns, earnings will continue to be skewed in favor of the already-rich with little growth real wages of workers, worsening income disparities.

There are those that think that increased concentrations of income, diversion of resources to the financial sector & an AWOL recovery require more regulations, more stimulus & perpetuation of current monetary policy. But all of these are symptoms of the same cause: “unconventional” monetary policy.

I often suggest that had I described the current policy as a sensible scenario during my doctoral-level studies on monetary policy during the 1970s, the professor would have failed me on the spot. (And probably thought I was a candidate for the looney-bin!) But today, these policy choices go unquestioned despite their perpetual failures.

It is imperative that we begin reversing the ruinous course that is being plotted that is disrupting investments in sustainable industrial projects as the basis for long-term economic growth. This can & will only begin when central bankers stop acting like central planners in setting interest rates.